ROUTE1 INC. MANAGEMENT S DISCUSSION AND ANALYSIS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, As at November 26, 2013

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1 ROUTE1 INC. MANAGEMENT S DISCUSSION AND ANALYSIS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 As at November 26, 2013 The following discussion and analysis of the financial condition and results of operations (this MD&A ) of Route1 Inc. (also referred to as we, us, our, Route1, or the Company ), should be read in conjunction with the Company s interim condensed consolidated financial statements and related notes as at and for the quarter ended September 30, The interim condensed consolidated financial statements have been prepared in accordance with International Accounting Standard ( IAS ) 34, Interim Financial Reporting as issued by the International Accounting Standards Board ( IASB ) and accounting policies the Company adopted in accordance with International Financial Reporting Standards ( IFRS ). This Management Discussion & Analysis ( MD&A ) has been reviewed and approved by the Company s Board of Directors prior to filing. The information in this MD&A is current to November 26, 2013, unless otherwise noted. FORWARD-LOOKING STATEMENTS The following discussion may contain forward-looking statements about matters that involve risk and uncertainties, such as statements of Route1 s plans, objectives, expectations and intentions, as well as financial trends. The discussion also includes cautionary statements about these matters. You should read the cautionary statements made below as being applicable to all forward-looking statements wherever they appear in this document. In drawing a conclusion or making a forecast or projection set out in the forwardlooking information, the Company takes into account the following material factors and assumptions in addition to the above factors: the Company s ability to execute on its business plan; the acceptance of the Company s devices and services by its customers; the timing of execution of outstanding or potential customer orders by the Company; the sales opportunities available to the Company; the Company s subjective assessment of the likelihood of success of a sales lead or opportunity; the Company s historic ability to generate sales leads or opportunities; and that sales will be completed at or above the Company s estimated margins. This list is not exhaustive of the factors that may affect our forward-looking information. These and other factors should be considered carefully and readers should not place undue reliance on such forward-looking information. Factors that could cause Route1 s actual results to differ materially from the forward-looking statements are contained herein and include, but are not limited to, overall economic conditions, competitive pressures and unexpected technology changes. Additional information concerning risks and uncertainties affecting Route1 s business and other factors that could cause financial results to fluctuate is set forth later in this document, as well as elsewhere herein, and is contained in Route1 s filing with Canadian securities regulatory authorities, available on the SEDAR website ( under Route1 Inc. and on the Company s website ( This MD&A includes additional disclosures on the critical accounting policies and estimates, additional disclosure on the quarterly selected financial information, additional discussion and analysis on the factors 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 1 of 25

2 affecting the Company s financial performance, additional disclosure on future liquidity and capital needs including the addition of a tabular presentation of contractual obligations, additional disclosure on the last eight quarters, and details of related party transactions. The Company does not believe that any of the additional information provided, and that has not been otherwise disclosed in other filings, is material in nature. INTELLECTUAL PROPERTY NOTICES Route1 Inc., All rights reserved. Route1, the Route1 and shield design Logo, SECURING THE DIGITAL WORLD, Mobi, MobiSecure, MobiLINK, Route1 MobiKEY, Route1 MobiVDI, MobiKEY, MobiKEY IBAD, DEFIMNET, MobiNET, Route1 MobiNET, TruOFFICE, TruFLASH, TruOFFICE VDI, MobiKEY Fusion, MobiNET Aggregation Gateway, MobiNET Switching Array, MobiNET Secure Gateway, EnterpriseLIVE, EnterpriseLIVE Virtualization Orchestrator, MobiNET Agent, MobiKEY Classic and MobiKEY Classic 2, are either registered trademarks or trademarks of Route1 Inc. in the United States and or Canada. All other trademarks and trade names are the property of their respective owners. The DEFIMNET and MobiNET platforms, the MobiKEY, MobiKEY Classic, MobiKEY Classic 2 and MobiKEY Fusion devices, and MobiLINK are protected by U.S. Patents 7,814,216 and 7,739,726, Canadian Patent 2,578,053 and other patents pending. Route1 Inc. is the owner of, or licensed user of, all copyright in this document, including all photographs, product descriptions, designs and images. OVERVIEW Route1 delivers industry-leading security and identity management solutions to corporations and government agencies that need universal, secure access to all digital resources and sensitive data. These customers depend on The Power of MobiNET - Route1 s communications and service delivery platform. MobiNET provides identity assurance and individualized access to networks and data. Route1 s patented solutions simplify the process of meeting increasingly stringent regulatory requirements for privacy and security. HIGHLIGHTS On March 13, 2013, the Company announced it had released MobiKEY 4.2. MobiKEY 4.2 includes updated features and security enhancements including: support for Windows 8 (Basic, Pro and Enterprise), Mac OS X functionality has been expanded to include remote printing, security updates and updated MobiNET Agent for the Host Asset. On March 21, 2013, the Company announced the release of MobiLINK. MobiLINK is an authentication and secure access technology that enables users to securely access internal web-enabled applications and web resources from anywhere in the world. MobiLINK features include: compatibility with ios based operating systems, real-time out of band tool to manage certificate based entitlements, centralized Policy Management for application entitlements and authorized MobiLINK versions, MobiLINK offers users exactly the same access remotely that they have at their office, multiple distributed internal applications can be accessed from MobiLINK, enterprise registration and deployment tools, connection history details for auditing and reporting purposes and easy to use application with no configuration required. On March 26, 2013, the Company announced that the U.S. Navy notified HP that an Authorization to 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 2 of 25

3 Operate (ATO) was recently granted for the Unclassified DEFIMNET MobiKEY Secure Remote Access Solution on the Unclassified NMCI Enterprise. This ATO authorizes NMCI and Washington Headquarters Services users to utilize the Unclassified DEFIMNET MobiKEY Secure Remote Access Solution. The Route1 MobiKEY solution for the U.S. Navy is composed of the DEFIMNET, Route1 s private communications and service delivery platform, its MobiKEY application software, and its MobiKEY Fusion device. On April 2, 2013, the Company announced the immediate availability of the MobiKEY technology for the Apple ipad. MobiKEY subscribers will now be able to use MobiKEY on an Apple ipad running ios 6 and higher. The MobiKEY technology includes the use of both Route1 s universal identity management and service delivery platform and MobiKEY application software. On April 5, 2013, the Company announced that the Canadian Intellectual Property Office has issued Route1 s first Canadian patent titled, System and Method for Accessing Host Computer Via Remote Computer. The Canadian patent application was originally filed on February 26, 2007, claiming priority from a corresponding U.S. patent application (now U.S. Patent No. 7,814,216), filed on September 7, On September 17, 2013, the Company released a white paper on the legal implications of BYOD. The paper outlines the wave of emerging legal pitfalls facing the Enterprise with respect to the current BYOD practices of comingling of personal and enterprise data on mobile devices. A copy of the white paper is available at: On September 23, 2013, the Company announced an order for 7,000 MobiKEY Fusion devices from a component of the U.S. Department of Homeland Security s (DHS). The DHS component will be replacing their allotment of MobiKEY Classic devices with Route1 s MobiKEY Fusion devices. Route1 expects to ship 7,000 MobiKEY Fusion devices between September 2013 and February The award has a sales value of approximately $700,000 USD. On October 15, 2013, the Company announced the unveiling of the MobiKEY Fusion A2T device. The MobiKEY Fusion A2T is an advanced tool for ID-1 smart car users (CAC, PIV and FRAC) who want to use an ipad, ipad mini, iphone or ipod touch to access data remotely. With this announcement, Route1 has expanded the number of mobile devices that ID-1 smart card users can utilize to securely access data via the MobiKEY technology. NON-IFRS FINANCIAL MEASURE: Adjusted EBITDA Within this MD&A we use the term Adjusted EBITDA (earnings before interest, income taxes, depreciation and amortization, stock-based compensation, restructuring and other costs). Adjusted EBITDA does not have any standardized meaning prescribed under IFRS and is therefore unlikely to be comparable to similar measures presented by other companies. We use Adjusted EBITDA, among other measures, to assess the operating performance of our ongoing businesses without the effect of amortization expense and stock-based compensation because it is largely dependent on the accounting methods and assumptions we use. Adjusted EBITDA allows us to compare our operating performance over time on a consistent basis. We believe that certain investors and analysts use Adjusted EBITDA to measure a company s ability to service 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 3 of 25

4 debt and to meet other payment obligations, or as a common valuation measurement in the technology industry. The table below reconciles Adjusted EBITDA to Operating profit (loss) before stock-based compensation for the quarters presented. In thousands of Canadian dollars Sept June Mar Dec Dec before award (i) Sept Sept before award (i) Adjusted EBITDA $22 $(7) $9 $645 $54 $514 $(77) Amortization 69 $ Operating profit (loss) before stock-based compensation $(47) $(79) $(41) $599 $8 $460 $(131) (i) On December 22, 2011, an award was granted to the Company in a JAMS arbitration bearing Reference No (the Arbitration ) between the Company and Qwest Government Services, Inc. See note ARBITRATION AWARD of this MD&A for additional information. SELECTED FINANCIAL INFORMATION The following table outlines selected unaudited financial information of the Company on a consolidated basis for the three and nine months ended September 30, 2013 and Route1 MD&A for the three and nine months ended September 30, 2013 Page 4 of 25

5 (in thousands of Canadian dollars, For the Three Months Ended For The Nine Months Ended except per share amounts) Sept 30 Sept 30 Sept 30 Sept 30 Sept 30 Sept before award (i) before award (i) STATEMENT OF OPERATIONS Revenue Devices and appliances $172 $123 $123 $234 $1,304 $231 Services 1,313 1,810 1,219 3,673 5,469 3,697 Total revenue 1,485 1,933 1,342 3,907 6,773 3,928 Cost of revenue , Gross profit 1,106 1,698 1,107 3,114 5,665 3,381 Operating expenses General administration ,016 2,199 2,199 Research and development Selling and marketing Total operating expenses 1,153 1,238 1,238 3,281 3,526 3,526 Operating profit (loss) before stockbased compensation (47) 460 (131) (167) 2,139 (146) Stock-based compensation (11) (145) (145) (206) (377) (377) Operating profit (loss) after stockbased compensation Interest income (58) (276) - (373) - 1, (523) 17 Foreign exchange translation (5) (85) (85) 91 (66) (66) Special charges - (70) (70) - (70) (70) Total comprehensive gain (loss) for the period $(63) $160 $(431) $(282) $1,643 $(642) Earnings (loss) per share $(0.00) $0.00 $(0.00) $(0.00) $0.00 $(0.00) CASH FLOW INFORMATION Operating activities $(1,115) $(785) $(785) $1,113 $2,007 $2,007 Investing activities (39) (76) (76) (440) (215) (215) Financing activities - (4) (4) - (483) (483) Net cash outflow (1,154) (865) (865) 673 1,309 1,309 Cash, beginning of period 2,582 2,261 2, Cash, end of period $1,428 $1,396 $1,396 $1,428 $1,396 $1,396 Working capital deficiency $(147) $(212) NA $(147) $(212) NA Total assets $3,365 $3,132 NA $3,365 $3,132 NA Shareholders equity (deficiency) $541 $(2) NA $541 $(2) NA (i) On December 22, 2011, an award was granted to the Company in a JAMS arbitration bearing Reference No (the Arbitration ) between the Company and Qwest Government Services, Inc. See ARBITRATION AWARD of this MD&A for additional information Route1 MD&A for the three and nine months ended September 30, 2013 Page 5 of 25

6 COMPARISON FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 Revenue Revenue for the three months ended September 30, 2013 was $1,484,920, representing a decrease of $448,478, from $1,933,398, for the same period in The comparison, discussed by segment, is as follows: Devices and Appliances Revenue from our MobiKEY devices (MobiKEY Classic 2 device, MobiKEY Classic device and the MobiKEY Fusion device) and appliances (the DEFIMNET platform and the MobiNET Aggregation Gateway) for the three months ended September 30, 2013 was $171,813, representing an increase of $48,480 from $123,333 for the same period in The increase is primarily a result of: As announced on September 23, 2013, during the quarter ended September 30, 2013 the Company shipped 1,000 devices to a component of the U.S. Department of Homeland Security for approximately $101,838. Devices and appliances revenue as a percentage of total revenue represents 11.6% of total revenue for the current period as compared to 6.4% for the prior year period. Services Revenue from our services segment (MobiKEY application software, and the DEFIMNET platform and other appliance licensing or yearly maintenance) for the three months ended September 30, 2013, was $1,313,107, representing a decrease of $496,958, from $1,810,065 for the same period in The decrease is primarily a result of: The Company recognized $590,874 of other services revenue from an arbitration award in the third quarter of See ARBITRATION AWARD of this MD&A for additional information. Services revenue, as a percentage of total revenue, represented 88.4% for the current period as compared to 93.6% for the prior year period. The table below provides information on the Company s service revenue during each of the last five quarters. Services revenue by quarters (in thousands of Canadian dollars) Sept June Mar Dec (i) Sept (i) MobiKEY application software revenue $1,139 $1,158 $853 $964 $954 Other services revenue Total $1,313 $1,333 $1,027 $1,756 $1,810 (i) On December 22, 2011, an award was granted to the Company in a JAMS arbitration bearing Reference No (the Arbitration ) between the Company and Qwest Government Services, Inc. See note ARBITRATION AWARD of this MD&A for additional information. The table below provides information on the number of and revenue amount for the MobiKEY application software subscribers during each of the last five quarters Route1 MD&A for the three and nine months ended September 30, 2013 Page 6 of 25

7 MobiKEY Subscribers (in thousands of Canadian dollars for Revenue) Sept June Mar Dec Sept Closing Number 14,642 14,784 13,989 15,913 14,615 Average Number (1) 14,697 15,159 13,853 14,870 14,779 Revenue per Subscriber $310 $306 $245 $259 $258 Revenue $1,139 $1,158 $853 $964 $954 (1) Calculated by taking the average of the closing MobiKEY subscriber number at the end of the month for each of the three months during the quarter. Gross Profit Gross profit is equivalent to revenue minus the cost of revenue. The cost of revenue primarily includes the cost of our devices and appliances sold to clients, as well as the cost of their shipping and packaging, plus the cost to operate and maintain the Route1 MobiNET platform. The cost of revenue for the three months ended September 30, 2013 was $378,658, representing an increase of $142,885, from $235,773 for the same period in A portion of the increase in cost of revenue for the three months ended September 30, 2013 is the result of increasing device and appliance sales which has higher cost compared to service revenue. Additionally, for the three months ended September 30, 2013, the Company incurred a devices and appliances write-down of $81,640 which was included in the cost of revenue. For additional information regarding the write-down see, DEVICES AND APPLIANCES HELD FOR SALE of this MD&A for additional information. Gross profit for the three months ended September 30, 2013 was $1,106,262 or 74.5% of gross revenue, representing a decrease of $591,363, from a gross margin of $1,697,625 or 87.8% of gross revenue for the same period in The decrease in gross profit is the result of the devices and appliances write-down of $81,640 during the three months ended September 30, 2013; and the Company recognizing $590,874 of revenue and gross profit in the third quarter of 2012 from an arbitration award. See ARBITRATION AWARD of this MD&A for additional information. Expenses Operating expenses consist of general administration, research and development, and selling and marketing. Operating expenses for the three months ended September 30, 2013 were $1,153,421, representing a decrease of $84,312, from $1,237,733 for the same period in General administration General administration expenses consist primarily of salaries and benefits for administration staff, professional fees, rent, telephone, computer related expenses, directors fees, insurance, bad debts, public company regulatory costs, depreciation and amortization and other indirect costs. General administration expenses for the three months ended September 30, 2013 were $665,909, representing a decrease of $85,302, from $751,211 for the same period in The majority of the change can be summarized as follows: Professional fees decreased by approximately $104,000 for the three months ended September 30, 2013 as compared to the same period in 2012, as a result of reducing outsourced human resource activities and investor relations activities. Amortization expense increased by approximately $14,000 for the three months ended September 30, 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 7 of 25

8 2013 as compared to the same period in 2012, as the Company continued to invest in technology infrastructure. Research and development Research and development expenses consist of salaries and benefits for the research and development department, and other professional fees associated with development work. Research and development expenses for the three months ended September 30, 2013 were $313,889, representing a decrease of $15,009, from $328,898, for the same period in 2012 and the majority of the change can be summarized as follows: Salaries and benefits decreased by $15,009 compared to the same period in 2012, as the Company reduced headcount in the department. Selling and marketing Selling and marketing expenses consist primarily of salaries and commissions, agent fees, marketing and trade shows, and travel and entertainment. Selling and marketing expenses for the three months ended September 30, 2013 were $173,623, representing an increase of $15,999, from $157,624 for the same period in 2012 and the majority of the change can be summarized as follows: Marketing cost, including travel, brand building and public relations, increased by approximately $39,000 for the three months ended September 30, 2013 as compared to the same period in Salaries, benefits and commission expenses decreased by approximately $22,000 compared to the same period in The reduction is the result of the Company refocusing the sales strategy. Other Items Stock-based compensation Stock-based compensation was $11,140 for the three months ended September 30, 2013, a decrease of $133,575, from $144,715 for the same period in A majority of this difference is the options of a former service provider being forfeited. Foreign exchange translation The loss attributable to foreign exchange translation on balance sheet items such as Accounts Receivable, Accounts Payable and foreign bank accounts was $4,951 for the three months ended September 30, 2013, a decrease of $80,219 from loss a of $85,170 for the same period in Special charges Special charges for the three months ended September 30, 2013 was $nil, compared to $69,820 in the same period in During the three months ended September 30, 2012 the Company engaged a New York City based investment bank as a financial advisor to identify potential partners to accelerate the Company s strategic business plan Route1 MD&A for the three and nine months ended September 30, 2013 Page 8 of 25

9 Comprehensive Income (loss) Comprehensive loss for the three months ended September 30, 2013 was $63,250 or $(0.00) per share, representing a decrease of $223,437 from a comprehensive gain of $160,187 or $0.00 per share for the same period in The gain for the three months ended September 30, 2012 is primarily the result of other service revenue recognized resulting from an arbitration award. See note ARBITRATION AWARD of this MD&A for additional information. COMPARISON FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012 Revenue Revenue for the nine months ended September 30, 2013 was $3,907,597, representing a decrease of $2,865,631 from $6,773,228 for the same period in The comparison, discussed by segment, is as follows: Devices and appliances Revenue from our MobiKEY devices (MobiKEY Classic 2 device, MobiKEY Classic device and the MobiKEY Fusion device) and appliances (the DEFIMNET platform and the MobiNET Aggregation Gateway) segment for the nine months ended September 30, 2013 was $234,475 representing a decrease of $1,069,547, from $1,304,022 for the same period in Devices and appliances revenue as a percentage of total revenue represents 6% of total revenue for the current period as compared to 19.3% for the same period in the prior year. The largest contributing factor to the decrease in devices and appliances revenue for the nine months ended September 30, 2013, was the result of an arbitration award, for which the Company recognized $1,072,488 of devices and appliances revenue during the nine months ended September 30, See ARBITRATION AWARD of this MD&A for additional information. Services Revenue from our services segment (MobiKEY application software, and the DEFIMNET platform and other appliance licensing or yearly maintenance) for the nine months ended September 30, 2013, was $3,673,122, representing a decrease of $1,796,084, from $5,469,206 for the same period in Services revenue, as a percentage of total revenue, represents 94% for the current period as compared to 80.7% for the same period in the prior year. A portion of the decrease in services revenue for the nine months ended September 30, 2013, was the result of an arbitration award, for which the Company recognized $1,772,622 of services revenue during the nine months ended September 30, See ARBITRATION AWARD of this MD&A for additional information. Deferred revenue as at September 30, 2013 increased by $1,274,479 to $2,405,779 from $1,131,300 as at December 31, The increase in the carrying amount of deferred revenue is primarily driven by a sale to a component of the United States Department of Defense covering the service period April 1, 2013 to March 31, Route1 MD&A for the three and nine months ended September 30, 2013 Page 9 of 25

10 Gross Profit Gross profit is equivalent to revenue minus the cost of revenue. The cost of revenue primarily includes the cost of our devices and appliances sold to clients, as well as the cost of their shipping and packaging, plus the cost to operate and maintain the Route1 MobiNET platform. The cost of revenue for the nine months ended September 30, 2013 was $793,419, representing a decrease of $314,578 from $1,107,997 for the same period in For the nine months ended September 30, 2013, the Company incurred a devices and appliances write-down of $81,640 which was included in the cost of revenue. For additional information regarding the write-down see, DEVICES AND APPLIANCES HELD FOR SALE of this MD&A for additional information. Gross profit for the nine months ended September 30, 2013 was $3,114,178 or 79.7% of gross revenue, representing a decrease of $2,551,053 from a gross margin of $5,665,231 or 83.6% of gross revenue for the same period in The decrease in cost of revenue and gross profit for the nine months ended September 30, 2013 is the result of an arbitration award recognized in As a result of the arbitration award the Company recognized $1,072,488 of devices and appliances revenue, $1,772,622 of services revenue and $560,522 of cost of revenue during the nine months ended September 30, See ARBITRATION AWARD of this MD&A for additional information. Expenses Operating expenses consist of general administration, research and development, and selling and marketing. Operating expenses for the nine months ended September 30, 2013 were $3,281,280, representing a decrease of $244,886, from $3,526,166 for the same period in General administration General administration expenses consist primarily of salaries and benefits for administration staff, professional fees, rent, telephone, computer related expenses, directors fees, insurance, bad debts, public company regulatory costs, depreciation and amortization and other indirect costs. General administration expenses for the nine months ended September 30, 2013 were $2,015,748, representing a decrease of $182,866, from $2,198,614 for the same period in 2012 and the majority of the change can be summarized as follows: Professional fees decreased by approximately $215,000 for the nine months ended September 30, 2013 as compared to the same period in 2012, as a result of reducing outsourced human resource activities and investor relations activities. Research and development Research and development expenses consist of salaries and benefits for the research and development department, and other professional fees associated with development work. Research and development expenses for the nine months ended September 30, 2013 were $758,993, representing a decrease of $34,584, from $793,577 for the same period in 2012 and the change can be summarized as follows: 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 10 of 25

11 The Scientific Research and Experimental Development credit increased by approximately $44,000 in 2013 as compared to 2012, as a result of more projects being eligible for the credit. Salaries and benefits expenses increased by approximately $10,000 for the nine months ended September 30, 2013 as compared to the same period in 2012, as a result of increases in salaries and headcount. Selling and marketing Selling and marketing expenses consist primarily of salaries and commissions, agent fees, marketing and trade shows, and travel and entertainment. Selling and marketing expenses for the nine months ended September 30, 2013 were $506,539, representing a decrease of $27,436, from $533,975 for the same period in 2012 and the majority of the change can be summarized as follows: Marketing cost, including travel, brand building and public relations, increased by approximately $93,000 for the nine months ended September 30, 2013 as compared to the same period in Salaries, benefits and commission expenses decreased by approximately $120,000 compared to the same period in The reduction is the result of the Company refocusing the sales strategy. Other Items Stock-based compensation Stock-based compensation was $206,422 for the nine months ended September 30, 2013, a decrease of $170,253 from $376,675 for the same period in The decrease in stock-based compensation is the result of options being forfeited, and select options vesting and no longer being expensed. Interest income/expense Interest income/expense for the nine months ended September 30, 2013 was $nil, compared to a net interest income of $16,668 for the same period in The interest income from 2012 is the result of an arbitration award; see ARBITRATION AWARD of this MD&A for additional information. Foreign exchange translation The gain attributable to foreign exchange translation on balance sheet items such as Accounts Receivable, Accounts Payable and foreign bank accounts was $91,337 for the nine months ended September 30, 2013, an increase of $157,741 from a loss of $66,404 for the same period in Special charges Special charges for the nine months ended September 30, 2013 was $nil, compared to $69,820 in the same period in During the nine months ended September 30, 2012 the Company engaged a New York City based investment bank as a financial advisor to identify potential partners to accelerate the Company s strategic business plan Route1 MD&A for the three and nine months ended September 30, 2013 Page 11 of 25

12 Comprehensive Income (loss) Comprehensive loss for the nine months ended September 30, 2013 was $282,187 or $(0.00) per share, a decrease of $1,925,021 from a comprehensive gain of $1,642,834 or $0.00 per share for the same period in SUMMARY OF QUARTERLY RESULTS The following table sets out selected unaudited financial information of the Company on a consolidated basis for the last eight quarters. The information has been derived from the Company s quarterly unaudited condensed interim consolidated financial statements that, in management s opinion, have been prepared on a basis consistent with the consolidated annual financial statements and are reviewed and approved by the Company s Board of Directors. The Company s quarterly operating results have varied substantially in the past and may vary substantially in the future. Accordingly, the information below is not necessarily indicative of results for any future quarter. As at and for the three month period ended (in thousands of Canadian dollars, except per share data) Sept June Mar Dec (i) Sept (i) June (i) Mar (i) Dec (i) STATEMENT OF OPERATIONS Revenue Devices and appliances $172 $33 $30 $521 $123 $60 $1,121 $175 Services 1,313 1,333 1,027 1,756 1,810 1,828 1,831 1,226 Total revenue 1,485 1,366 1,057 2,277 1,933 1,888 2,952 1,401 Cost of revenue Gross margin 1,106 1, ,823 1,698 1,703 2,264 1,168 Operating expenses General administration ,236 Research and development Selling and marketing Total operating expenses 1,153 1, ,225 1,238 1,113 1,176 2,672 Operating profit (loss) before stockbased compensation (47) (79) (41) ,088 (1,504) Adjusted EBITDA 22 (7) ,125 (1,464) Stock-based compensation (11) (70) (125) (103) (145) (164) (68) (128) Operating profit (loss) after stockbased compensation (58) (149) (166) ,020 (1,632) Interest income/(expense) Foreign exchange translation (5) (85) 74 (55) (32) Severance charges Special charges (70) Comprehensive (loss) gain for the period $(63) $(73) $(146) $515 $160 $500 $983 $(1,081) Earnings (loss) per share $(0.00) $(0.00) $(0.00) $(0.00) $0.00 $0.00 $0.00 $(0.00) 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 12 of 25

13 CASH FLOW INFORMATION Operating activities $(1,115) $1,110 $1,118 $(379) $(785) $1,086 $1,706 $175 Investing activities (39) (354) (47) (263) (76) (122) (18) (27) Financing activities (4) (188) (290) (85) Net cash inflow (outflow) (1,154) 756 1,071 (642) (865) 776 1, Cash, beginning of period 2,582 1, ,396 2,261 1, Cash, end of period $1,428 $2,582 $1,826 $754 $1,396 $2,261 $1,485 $87 BALANCE SHEET INFORMATION Working capital (deficiency) $(147) $(123) $172 $190 $(212) $(493) $(901) $(1,707) Total assets $3,365 $4,587 $3,567 $2,503 $3,132 $4,067 $2,765 $5,999 Shareholders equity (deficiency) $541 $593 $596 $617 $(2) $(302) $(778) $(1,539) (i) On December 22, 2011, an award was granted to the Company in a JAMS arbitration bearing Reference No (the Arbitration ) between the Company and Qwest Government Services, Inc. See ARBITRATION AWARD of this MD&A for additional information. The Company s revenue and financial results are difficult to forecast and have historically fluctuated on a quarterly basis, and it is expected that quarterly revenue and financial results will continue to fluctuate in the future as the Company continues growing. Fluctuations in results are related to the growth of the Company s revenue, the timing of revenue being recognized and sales to customers, who may place large single orders in any one quarter, and the timing of staffing and infrastructure additions to support growth. LIQUIDITY AND CAPITAL RESOURCES Management continually assesses liquidity in terms of the ability to generate sufficient cash flow to fund business activities. Net cash flow is affected by the following items: i) operating activities, including the level of accounts receivable, inventory, prepaid expenses, accounts payable and deferred revenue; ii) investing activities, including the purchase of capital assets; and iii) financing activities, including the issuance of capital stock. Cash flow generated by operating activities Cash flow generated by operating activities for the three months ended September 30, 2013 were $98,402, compared to cash flow generated of $359,434 in the same period in 2012, representing a decrease of $261,032. Net change in working capital activities used of $1,213,526 for the three months ended September 30, 2013 compares to net change in working capital activities used of $1,144,058 in the same period a year earlier. Therefore net cash used in the day-to-day operations for the three months ended September 30, 2013 was $1,115,124 compared to net cash used of $784,621 in the same period in 2012, representing an increase in cash used of $330,503. The increase in cash used during the three months ended September 30, 2013 compared to the same period in the prior year was mainly due to the timing of certain customer renewals, the reduction of stock-based compensation and timing of accounts receivables and payables. Cash flow generated from operating activities for the nine months ended September 30, 2013 was $196,472, compared to cash flow generated of $2,153,498 in the same period in 2012, representing a decrease of $1,957,026. Net change in working capital activities generated $916,719 for the nine months ended September 30, 2013 compared to $146,093 used in the same period a year earlier. Therefore net cash 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 13 of 25

14 generated in the day to-day operations for the nine months ended September 30, 2013 was $1,113,191 compared to $2,007,405 in the same period in 2012, representing a decrease of $894,214. The decrease in net cash generated for the nine months ended September 30, 2013 compared to the same period in the prior year is mainly the result of the Qwest arbitration award in In the nine months ended September 30, 2012 the Company was able to collect the award, make payment for legal fees to obtain the award and increase deferred revenue accordingly. See ARBITRATION AWARD of this MD&A for additional information. Cash flow used in investing activities Cash flow used in investing activities for the three months ended September 30, 2013 was $38,931 compared to cash flow used of $75,880 in the same period in 2012, representing a decrease in the outflow of cash of $36,949. Cash flow used in investing activities for the nine months ended September 30, 2013 was $440,196 compared to cash flow used of $215,457 in the same period in 2012, representing an increase in the outflow of cash of $224,739. This increase was the result of additional fixed assets being purchased during the period when compared to the same period in the prior year. Cash flow used in financing activities Cash flow used in financing activities for the three months ended September 30, 2013 was $nil compared to cash outflows of $4,500 for the same period in 2012, representing a decrease in cash usage of $4,500. The cash outflow for the three months ended September 30, 2012 is a direct result of the repurchase of capital stock for cancellation. For additional information see SHARE REPURCHASE PROGRAM of this MD&A. Cash outflows by financing activities for the nine months ended September 30, 2013 was $nil compared to cash outflows of $482,521 for the same period in 2012, representing a decrease in cash used of $482,521. The cash outflow for the nine months ended September 30, 2012 is a direct result of the repurchase of capital stock for cancellation. For additional information see SHARE REPURCHASE PROGRAM of this MD&A. The Company s current business plan and sales forecast projects revenue growth in 2013 and beyond. The Company believes that its success in securing sales contract vehicles and/or growing sales with the U.S. government will lead to growth within the U.S. government and future opportunities abroad with other governments. The Company s need for capital expenditures is limited to such items as computer hardware and software, expenditures to support sales, marketing and general administration activities and working capital. Since inception, the Company has financed its cash and/or capital requirements through operating cash flow, the issuance of equity from private placements, and through the issuance of obligations under capital leases. On October 4, 2011, the Company entered into a $550,000 credit facility with a banking and financial services organization consisting of a $500,000 revolving demand operating facility and a $50,000 credit card facility. The revolving demand credit facility carries an interest rate equal to the lender s prime rate of interest plus 1.80%. The credit facility is secured by the assets of the Company. There is no minimum collateral asset value to access the first $100,000; accessing an amount in excess of $100,000 shall be based 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 14 of 25

15 on the balance and term of the Company s trade accounts receivables outstanding plus the amount of SR&ED tax credits filed and refundable. The Company is required to maintain a current ratio in excess of 0.75:1.0 while any portion of the demand facility is outstanding and a Funded Debt to EBITDA ratio (calculated on a yearly basis) of not greater than 2.50:1. The Company had not drawn on the facility as of September 30, The following table discloses future payments as at September 30, 2013 committed by the Company over the next five (5) years and thereafter. It includes both principal and interest obligations required under capital lease agreements. Contractual Obligations Later than one year Total No later than 1 year and not later than five Later than five years years Operating leases $1,912,499 $230,747 $1,251,115 $430,637 OFF-BALANCE SHEET ARRANGEMENTS The Company has not entered into any off balance sheet arrangements. DEVICES AND APPLIANCES HELD FOR SALE On a quarterly basis or when necessary management reviews the carrying value of inventory. Under IFRS, inventory must be recognized at the lower of cost or their Net Realizable Value, which is the estimated selling price in the ordinary course of business less the estimated costs of completion and estimated costs necessary to make the sale. During the quarter ended September 30, 2013, management reviewed the sales mix of its MobiKEY Classic 2 device, MobiKEY Classic device and the MobiKEY Fusion device. In so doing, the Company forecast continued strong demand for the MobiKEY Classic 2 device and MobiKEY Fusion device when compared to the MobiKEY Classic device. As a result, for the three and nine months ended September 30, 2013, the Company incurred a write-down of MobiKEY Classic devices in the amount of $81,640. RELATED PARTY TRANSACTIONS The Company has directors and officers who are considered related parties. The Company had the following transactions and/or outstanding amounts with related parties for the three and nine months ended September 30, 2013, with 2012 comparatives. All transactions are recorded at their exchange amounts and can be referenced to the Company s management proxy circular as dated October 9, A copy of the circular can be found on The Company made payments (including HST) to Ontario Inc. for management services provided by Mr. Tony P. Busseri, a director and the CEO of the Company in the amount of $101,700 for the three months ended September 30, 2013 (September 30, $101,700) and $322,050 for the nine months ended September 30, 2013 (September 30, $319,225). Additional details regarding the employment contract can be found in the Company s management proxy circular dated October 9, The Company incurred expenses (including CPP) payable to and on behalf of the independent members of the Board of Directors of $70,111 for the three months ended September 30, 2013 (September 30, $56,361) and $213,266 for the nine months ended September 30, Route1 MD&A for the three and nine months ended September 30, 2013 Page 15 of 25

16 (September 30, $151,992). These transactions are in the normal course of operations and are paid or payable for directorship services. The Company made payments to or incurred expenses for key management (President, Chief Technology Officer, and the Chief Financial Officer) in the three months ended and nine months ended September 30, 2013 as follows, with 2012 comparatives. Additional details regarding the employment contracts can be found in the Company s management proxy circular dated October 9, Three Months Ended September 30, 2013 Three Months Ended September 30, 2012 Nine Months Ended September 30, 2013 Nine Months Ended September 30, 2012 Short-term employee benefits $152,500 $146,250 $492,500 $445,000 Stock option expense 30,181 71, , ,996 $182,681 $217,809 $641,843 $700,996 PROPOSED TRANSACTIONS The Company has not entered into any asset or business acquisition or disposition transactions. CRITICAL ACCOUNTING ESTIMATES The consolidated financial statements have been prepared in accordance with International Accounting Standard ( IAS ). Management makes certain estimates and relies on certain assumptions relating to reporting the Company s assets and liabilities as well as operating results in order to prepare the unaudited financial statements in conformity with IFRS. On an on-going basis, the Company evaluates its estimates and assumptions including those related to revenue, the valuation of accounts receivable, the estimation of useful lives of the various classes of capital assets, stock-based compensation expense, and the measurement of income tax valuation allowances. Actual results could differ from those estimates, which are as follows: The Company s revenue is derived from hardware (i.e. MC2 device, the MobiKEY Classic device and the MobiKEY Fusion device) sales and subscription services (i.e. MobiKEY application software). The Company recognizes revenue in accordance with IAS 18, Revenue. In the determination of the valuation of accounts receivable, including the allowance for doubtful accounts, the Company relies on current customer information, payment history and trends as well as future business and economic conditions. The determination of inventory obsolescence allowance. The determination of fair value of investments (if any) is based on a discounted cash flow model. The estimation of useful lives of the various classes of capital assets is based upon history and experience of similar assets within each class. The fair value of stock options is based on certain estimates applied to the Black-Scholes option-pricing model as disclosed in the Company s financial statements. The measurement of the income tax valuation allowance is based upon estimates of future taxable income and the expected timing of reversals of temporary differences Route1 MD&A for the three and nine months ended September 30, 2013 Page 16 of 25

17 FUTURE ACCOUNTING POLICY CHANGES Consolidated Financial Statements IFRS 10, Consolidated Financial Statements (IFRS 10), effective for annual periods beginning on or after January 1, 2013, with early adoption permitted, builds on existing principles by identifying the concept of control as the determining factor in whether an entity should be included within the consolidated financial statements of the parent company. This standard has been adopted in the Company s consolidated financial statements for the period beginning January 1, Management has determined there is no impact from the adoption of IFRS 10. IAS 27, Separate financial statements (IAS 27), was re-issued by the IASB in May 2011 to only prescribe the accounting and disclosure requirements for investments in subsidiaries, joint ventures and associates when an entity prepares separate financial statements. The consolidation guidance will now be included in IFRS 10. The amendments to IAS 27 are effective for annual periods beginning on or after January 1, This standard has been adopted in the Company s consolidated financial statements for the period beginning January 1, Management has determined there is no impact from the adoption of this standard. Fair Value Measurement IFRS 13, Fair Value Measurement (IFRS 13), defines fair value, sets out in a single IFRS a framework for measuring fair value and requires disclosures about fair value measurements. IFRS 13 applies when another IFRS requires or permits fair value measurements or disclosures about fair value measurements (and measurements, such as fair value less costs to sell, based on fair value or disclosures about those measurements), except for: share-based payment transactions within the scope of IFRS 2, Share-based Payment ; leasing transactions within the scope of IAS 17, Leases ; measurements that have some similarities to fair value but that are not fair value, such as net realizable value in IAS 2, Inventories or value in use in IAS 36, Impairment of Assets. This standard is effective for annual periods beginning on or after January 1, This standard has been adopted in the Company s consolidated financial statements for the period beginning January 1, Management has determined there is no impact from the adoption of IFRS 13. FINANCIAL INSTRUMENTS Establishing fair value The carrying amount of financial instruments including cash and cash equivalents, accounts receivable and accounts payable and other liabilities approximates fair value because of the short-term nature of these instruments. The following table sets out the classification, carrying amount, and fair value of the Company s financial assets and liabilities as at September 30, 2013 and December 31, 2012: 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 17 of 25

18 September 30, 2013 December 31, 2012 Carrying Amount Fair Value Carrying Amount Fair Value FINANCIAL ASSETS Loans and receivables Cash and cash equivalents (i) $1,427,504 $1,427,504 $754,509 $754,509 Accounts receivable (i) $284,074 $284,074 $285,688 $285,688 FINANCIAL LIABILITIES Other liabilities Accounts payable and other liabilities (i) $289,713 $289,713 $624,246 $624,246 (i) The fair value of these instruments is their carrying amount due to their short-term nature. FINANCIAL INSTRUMENTS - RISK MANAGEMENT The Company has exposure to credit risk, liquidity risk and market risk associated with its financial assets and liabilities. The Board has overall responsibility for the establishment and oversight of the Company s risk management framework. The Board has established the Audit Committee which is responsible for monitoring the Company s compliance with risk management policies. The Audit Committee regularly reports to the Board on its activities. The Company s risk management program seeks to minimize potential adverse effects on the Company s financial performance and ultimately shareholder value. The Company manages its risks and risk exposures through a system of internal controls and sound business practices. The Company s financial instruments and the nature of the risks to which they may be subject are set out in the following table: Credit Liquidity Risks Foreign Exchange Interest Rate Credit risk Cash and cash equivalents Yes Yes Yes Accounts receivable Yes Yes Accounts payable and other liabilities Yes Yes Credit risk arises from cash held with banks and credit exposure to customers, including outstanding accounts receivable. The maximum exposure to credit risk is equal to the carrying value (net of allowances) of the financial assets. The objective of managing credit risk is to prevent losses on financial assets. The Company assesses the credit quality of counterparties, taking into account their financial position, past experience and other factors. During the quarter ended September, 2013, the largest single customer reseller represented approximately $568,039 of recorded revenue (September 30, $511,219) Route1 MD&A for the three and nine months ended September 30, 2013 Page 18 of 25

19 Cash and cash equivalents Cash and cash equivalents consist of bank balances. Credit risk associated with cash is minimized substantially by ensuring that these financial assets are held in highly rated financial institutions. At September 30, 2013, the Company had cash consisting of cash on hand and deposits with banks of $1,427,504 (December 31, $754,509). Accounts receivable Accounts receivable consist primarily of accounts receivable from invoicing of devices and services. The Company s credit risk arises from the possibility that a customer which owes the Company money is unable or unwilling to meet its obligations in accordance with the terms and conditions in the contracts with the Company, which would result in a financial loss for the Company. This risk is mitigated through established credit management techniques, including monitoring customer s creditworthiness, setting exposure limits and monitoring exposure against these customer credit limits. The carrying amount of accounts receivable is reduced through the use of an allowance for doubtful accounts and the amount of the loss is recognized in the statement of operations. When a receivable balance is considered uncollectible, it is written off against the allowance for accounts receivable. Subsequent recoveries of amounts previously written off reduce other expenses in the statement of operations. As at September 30, 2013, the largest single customer s accounts receivable represented approximately 35% (September 30, %) of the total accounts receivable. Subsequent to September 30, 2013 all of the outstanding accounts receivable as at September 30, 2013 was collected in full. The following table outlines the details of the aging of the Company s receivables as at September 30, 2013 and December 31, 2012: September 30, 2013 December 31, 2012 Current $238,365 $86,708 Past due 1 60 days 45, ,980 Greater than 60 days - - Less: Allowance for doubtful accounts - - Total accounts receivable, net $284,074 $285,688 For the quarter ended September 30, 2013 and year ended December 31, 2012 there was a $nil balance for the allowance for doubtful accounts. Liquidity risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company s objective in managing liquidity risk is to maintain sufficient readily available reserves in order to meet its liquidity requirements at any point in time. In order to meet its financial liabilities, the Company has recently relied on collecting its accounts receivable, which by nature, are due predominately from government agencies with a high level of certainty of collection. The Company s ability to manage its liquidity risk going forward will require some or all of the following: the ability to secure capital and/or credit facilities on reasonable terms in the current market place and its 2013 Route1 MD&A for the three and nine months ended September 30, 2013 Page 19 of 25

20 ability to generate positive cash flows from operations. Accounts payable of $289,713 (December $624,246) are outstanding as of September 30, The following table details the Company s contractual maturities for its financial liabilities, including interest payments and operating lease commitments, as at September 30, 2013: and Beyond Total Accounts payable and other liabilities $289,713 $- $- $289,713 Operating lease commitments 57, ,636 1,623,547 1,912,500 $347,030 $231,636 $1,623,547 $2,202,213 Market risk Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates will affect the fair value of recognized assets and liabilities or future cash flows or the Company s results of operation. Foreign exchange The functional currency of the parent company is Canadian dollars and the reporting currency is Canadian dollars. As at September 30, 2013, the Company had non-canadian dollar net monetary assets of approximately US$355,013 and 5,108 (December 31, approximately US$801,602 and 78,673). An increase or decrease in the U.S. to Canadian dollar exchange rate by 5% as at September 30, 2013 would have resulted in a gain in the amount of $18,289 or a loss of $18,289. Similarly, an increase or decrease in the Euro to Canadian dollar exchange rate by 5% as at September 30, 2013 would have resulted in a gain in the amount of $356 or a loss of $356. Any gain or loss would have been included in the determination of net income. Interest rate The Company has cash balances which maybe exposed to interest rate fluctuations. At September 30, 2013, cash totalled $1,427,504 (December 31, $754,509). SHARE REPURCHASE PROGRAM On February 27, 2012, the Company announced with approval from the TSX Venture Exchange its intention to make a Normal Course Issuer Bid ( NCIB ). The NCIB enabled the Company to purchase for cancellation up to 10% of the common shares in the public float as at February 17, The maximum number of shares allowed for repurchase was 35,480,904. Purchases under the NCIB took place during the 12 month period commencing February 29, 2012 and ending February 28, 2013, or the date upon which the maximum number of common shares have been purchased by the Company. During the prior year three month period ended September 30, 2012, the Company repurchased for cancellation 100,000 of its common shares for a total consideration of $4,500, at an average price of $0.045 per share under the NCIB. The Company made no share repurchase for the three month period ended September 30, Route1 MD&A for the three and nine months ended September 30, 2013 Page 20 of 25